RIIO-T1: Final Proposals for National Grid Electricity Transmission and National Grid Gas

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for all gas and electricity customers

RIIO-T1: Final Proposals for National Grid

Electricity Transmission and National Grid Gas

Outputs, incentives and innovation Supporting

Document

Reference: 169/12 Contact Grant McEachran

Publication date: 17 December

2012 Team: RIIO-T1

Tel: 0141 331 6008

Email: grant.mceachran@ofgem.gov.uk

Overview:

This Supporting Document sets out further detail on our Final Proposals on the outputs,

incentives and innovation within the next transmission price control (RIIO-T1) for National Grid Electricity Transmission (NGET) and National Grid Gas (NGGT) from 1 April 2013 to 31 March 2021.

Alongside this document we are publishing two other Supporting Documents on Cost assessment and uncertainty, and Finance.

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1. Introduction

Chapter Summary

This chapter explains the structure and purpose of this document, and of the associated documents published alongside it. The chapter also summarises our approach to setting outputs, incentives, and providing for innovation in setting our Final Proposals for National Grid Electricity Transmission (NGET) and National Grid Gas (NGGT).

Purpose of this document

1.1. Under the RIIO process, network companies are required to take into account the needs and views of stakeholders in order to submit well-justified business plans to us. Our March Strategy Document for RIIO-T11_{set out decisions on the key}

aspects of the regulatory framework. It also set out what we expected to see in a well-justified business plan, and the criteria against which we would assess such a plan. We used five broad criteria to assess the plans:

Process: has the company followed a robust process? Outputs: does the plan deliver the required outputs?

Resources (efficient expenditure): are the costs of delivering the outputs efficient?

Resources (efficient financial costs): are the proposed financing arrangements efficient?

Uncertainty/risk: how well does the plan deal with uncertainty and risk?

1.2. This document aims to provide further detail to support the Final Proposals Overview Document in relation to the second of those criteria - the outputs that the companies have to deliver and the incentive arrangements around delivery. It also details the elements of the framework intended to encourage innovation.

1.3. Alongside this document and the Overview Document2_{we have published two}

Requirement to deliver outputs and setting the incentives

1.9. RIIO is an outputs-led framework. It is important that throughout the RIIO-T1 period the transmission owners (TOs) understand what they are expected to deliver, and are held to account for delivery.

1.10. Our March Strategy Document set out the outputs we expected NGET and NGGT to deliver in the RIIO-T1 period. We developed these through written consultation and stakeholder workshops.

1.11. The outputs set out in the March Strategy Document provided the context for NGET‟s and NGGT‟s July 2011 and March 2012 business plans. We explicitly stated that TOs could propose departures from our March Strategy Document on particular outputs. In such cases, the TO would be required to describe its proposed approach clearly. It would also need to justify why the alternative was likely to improve expected outcomes for consumers, compared to the position set out in our Strategy Document.

Assessing performance against outputs

1.12. Under RIIO, we will generally consider NGET‟s or NGGT‟s performance against its outputs on an annual basis. We will set out in our Regulatory Instructions and Guidance (RIGs) information requirements and further detail on the reporting and monitoring arrangements. We consulted on draft RIGs on 30 October 2012. We intend to consult on the final RIGs in February 2013.

1.13. In RIIO, non-delivery of these outputs is not just a matter for the applicable financial incentives. NGET and NGGT are also accountable for delivery through their licence. We may take enforcement action where applicable where there is delivery failure. This means that even where there is a limit to the financial incentive associated with poor delivery, for example in the case of reliability, the licence enforcement process remains as a backstop. This provides additional protection for consumers in the case of significant underperformance on output delivery. Where both enforcement and financial incentives apply, the enforcement decision would take account of any financial incentives applied.

1.14. For the avoidance of doubt, we confirm that NGET‟s or NGGT‟s revenues or allowances can be adjusted downwards if it does not deliver the level of outputs for

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which it has been funded. We will make an allowance adjustment for the amount of underdelivery after an assessment of actual outputs against the expected level of output delivery set out in Final Proposals or NGET‟s/NGGT‟s licence, or derive an allowance adjustment using the parameters of an output volume driver if one is operating in respect of the output.

Setting the level of incentives

1.15. Under RIIO it is not possible to set out the actual level and profile of annual allowed revenue that NGET and NGGT can collect. This is due, in part, to within period revenue flexing mechanisms that will adjust the opening base revenue allowances. Examples of mechanisms that can alter allowed revenue over the price control period include the uncertainty mechanisms, the Strategic Wider Works (SWW) mechanism and the application of the efficiency incentive rate.

1.16. In order to maintain strong output incentives we intend to make sure that where caps and collars apply to these, they do not just reflect the starting position on revenue called the opening base revenue allowance. Instead, we propose that they adjust in response to ongoing, but uncertain, changes in revenue in order to reflect more accurately the true change in network total expenditure (totex) and other in-period adjustments over the price control period.

1.17. To do this, we propose that the maximum caps and collars will be linked to a combination of the opening base revenue allowance plus within-period adjustments captured through annual iteration of the financial model and, for NGET, the revenue from Transmission Investment in Renewable Generation (TIRG).8_{This will include all}

extra totex that is triggered during the RIIO-T1 price control period.

1.18. In Final Proposals the Totex Incentive Mechanism will apply to those incentive rates that have been set to equal the economic value of the output, ie the incentive rates for sulphur hexafluoride and energy not supplied. This is necessary to ensure that NGET faces the appropriate economic incentives to take decisions on the level of outputs it delivers that are in the interests of consumers. For the same reason, we have decided to include a tax adjustment on these incentives to address the different tax treatment of any over or under spend and output incentive reward/penalty. Note that this issue does not arise in relation to any of NGGT‟s output incentives. Lastly, we will preserve the economic value of these incentives during the price control period by adjusting for the rate of RPI inflation.

Managing charging volatility

8_{TIRG is a mechanism designed to fund transmission projects specific to connecting}

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1.19. While we do not determine charges, the changes in allowed revenue at the start and during the RIIO-T1 period impacts on the network companies‟ customers through the network charges. We recognise that our proposals can add to volatility in these charges and that the degree of notice before significant changes are made to charges is a critical issue to network companies‟ customers and to end consumers. When setting the RIIO-T1 framework we have considered how we might manage the volatility that necessarily results from an incentive regime that rewards outputs, penalises under-performance and provides a flexible regulatory framework that can cope robustly with uncertainty.

1.20. In April 2012 we consulted on five options for managing charging volatility:

Improved information for suppliers and customers Restricting the frequency of intra-year charge changes

Increasing the lag on incentive rewards/penalties that networks recover through allowed revenues

Increasing the lag on adjustments to allowed revenues from uncertainty mechanisms

Imposing a cap and collar on changes to allowed revenues.

1.21. In September 2012, we published our decision which proposed to implement the first three options. While rejecting the imposition of a cap and collar on changes to allowed revenues, we also proposed to increase the lag on adjustments to allowed revenues from uncertainty mechanisms in some cases. In relation to the financial incentives discussed in this document, this means that we are planning to manage their impact on charging volatility. This will generally be through a lag in the impact they have on allowed revenues and/or significant advance knowledge about changes.

1.22. We will reflect this decision in the statutory consultation on the licence conditions to be published on Friday 21 December 2012.

Funding RIIO-T2 outputs Our Initial Proposals

1.23. In Initial Proposals we proposed to disallow the baseline allowances that NGET requested in its business plan for outputs which may be required in the next

transmission price control period, RIIO-T2 (circa £425m), after adjustments such as for unit cost efficiencies. We did not consider it appropriate to include baseline allowances for this expenditure in view of the uncertainty about what might turn out to be required. This is in line with the RIIO principle of matching expenditure to outputs.

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covered by the totex incentive mechanism. We also set out the principle that NGET would be remunerated for the total efficient costs it incurred in RIIO-T1 for outputs delivered in RIIO-T2. We proposed that we would assess this as part of setting the price control for the next period, also taking into account any totex incentive mechanism adjustments.

Responses to Initial Proposals

1.25. NGET has said that under these arrangements it would incur significant costs in advance of funding, and that these costs did not seem to be reflected in our financeability modelling.

1.26. NGET also noted that we said in the RIIO Handbook9_{that expenditure for the}

delivery of outputs in future price control periods could be included as part of the price control, subject to the company providing evidence that the benefits of this expenditure will be observed in future price controls, and is related to delivering long-term value for money.

Our Final Proposals

1.27. In response to NGET‟s concerns, we have further assessed the financial implications of the RIIO-T2 expenditure as per our Initial Proposals under different scenarios. We set out the assumptions we used in these stress tests in our

Supporting Document on Finance. Overall, we find that our proposals are robust to a range of downside scenarios, including expenditure relating to outputs delivered in RIIO-T2.10

1.28. Although our analysis confirms that the approach set out in Initial Proposals is financially sustainable for the company, we have also considered other potential implications of this approach on NGET in carrying out work for delivery of outputs in future price control periods. For example, we recognise that without clarity on the efficient costs of delivering outputs there is a risk that NGET may seek to defer load-related projects into RIIO-T2 to fund more expensive projects through the baseline. As a result, we consider it is in existing and future consumers‟ interests, and in line with the RIIO principles generally, to ensure that the company has strong incentives to deliver these customer-driven outputs efficiently and in a timely manner.

1.29. Accordingly we intend to change our proposals in this area. However, given the level of uncertainty about what might turn out to be required,we retain our position of not including baseline allowances in RIIO-T1 for RIIO-T2 outputs. Instead we are including in Final Proposals an additional funding mechanism for NGET to trigger a funding adjustment to cover this expenditure should it be needed. This will work through the respective volume drivers in each load-related area, using the unit cost allowances agreed for RIIO-T1 and the generic spend profile that is also

9_{Handbook for implementing the RIIO model – Ofgem 4 October 2010}

http://www.ofgem.gov.uk/Networks/rpix20/ConsultDocs/Documents1/RIIO%20handbook.pdf.

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included as part of the volume drivers. The benefit of this approach is that there will be a much clearer link between the costs NGET has incurred in the RIIO-T1 period and outputs that the company can be held to account to deliver during RIIO-T2. More details about how and when this funding adjustment will be triggered and when it will take effect are set out in the Cost assessment and uncertainty Supporting Document.

Structure of this document

1.30. The remainder of this document is structured as follows:

Chapter 2 sets out our Final Proposals for the outputs and incentives that will apply to NGET

Chapter 3 sets out our Final Proposals for the outputs and incentives that will apply to NGGT

Chapter 4 sets out the proposed arrangement that will apply to encourage NGET and NGGT to innovate and to meet the requirements of their innovation strategies.

1.31. We intend to publish licence modifications for statutory consultation on Friday 21 December 2012.

1.32. All monetary amounts in this document are in 2009-10 prices unless otherwise stated. There may be slight differences between tables due to the rounding of

numbers.

1.33. Figure 1.1 provides a map of the RIIO-T1 Final Proposals documents.

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RIIO-T1: Final Proposals for NGET and NGGT – Overview Document

RIIO-T1 Supporting Documents

Outputs, incentives and innovation • Primary outputs • Secondary deliverables • Output incentives • Innovation stimulus

Cost assessment and uncertainty • Capital expenditure • Operating expenditure • Information Quality Incentive • Uncertainty mechanisms Finance

• Asset life & RAV • Allowed return • Financeability, transition, RORE • Pensions • Taxation • Allowed revenues • Annual iteration process

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2. NGET: Outputs and incentives Final

Proposals

Chapter Summary

This chapter sets out our Final Proposals in relation to outputs and incentives that will apply to NGET.

Introduction

2.1. This chapter considers each output area in turn and considers what we are requiring NGET to deliver over RIIO-T1. It also sets out the detail of associated incentives that apply around NGET‟s delivery during RIIO-T1.

Outputs we are requiring NGET to deliver over RIIO-T1

Safety

Our Initial Proposals

2.2. Our Initial Proposals in relation to safety were for NGET to be compliant with its legal safety requirements. These are requirements monitored by the Health and Safety Executive (HSE), as the safety regulator.

2.3. In addition, our Initial Proposals also required NGET to maintain and report annually on a suite of network output measures (NOMs) on criticality, replacement priorities (or risk), system unavailability, average circuit unreliability (ACU), faults and failures. These measures inform both the safety and reliability of NGET‟s network. The measures are important despite not involving direct financial incentives. Performance against them informs us about the ability of NGET to continue to deliver a safe and reliable network both into, and throughout, the next price control period.

2.4. We received no specific responses in this area. NGET confirmed its support for the proposal for the safety primary output. NGET had comments on the secondary measures on asset health and condition, and we explore these under the reliability section below.

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Reliability

2.6. In our Initial Proposals, we proposed that NGET be held to account for delivering an output on the level of energy not supplied (ENS) each year. A target level of 316MWh per annum would apply during the RIIO-T1 period. The incentive rate would be £16,000 per MWh, with the company gaining reward for delivering a lower level of ENS and incurring a penalty for each MWh worse than the 316MWh target. We proposed to maintain the level of the incentive rate in real terms for the price control period. The incentive has a natural cap, as NGET cannot reduce ENS below zero. Our Initial Proposals proposed to limit the downside risk from this incentive by applying a 3 per cent collar, which is consistent with our assessment of the risk of NGET‟s overall package.

2.7. These Initial Proposals also envisaged the ENS incentive being subject to a number of exclusions. These were to completely exclude ENS related to customer-choice connections and events lasting less than or equal to three minutes. In other cases, such as extreme weather events, we proposed that it will be a matter for Ofgem to understand the specific circumstances of the case before deciding whether to exclude any ENS from this incentive.

2.8. The NOMs are secondary deliverables that provide us with a measure to monitor and assess transmission owners (TO)s‟ asset renewal performance over the longer-term. They are a leading indicator of asset performance.

2.9. For Initial Proposals we set out the detail on how we reconcile asset replacement volume and NOMs under the non-load-related (NLR) investment programme. We proposed that we will take the NOMs target of RIIO-T1 as the opening position from which a TO will be funded to deliver the NOMs target of RIIO-T2. Under this approach any under or over delivery in RIIO-T1 would either require catch-up or carry-forward by the TO in order to meet its RIIO-T2 NOMs target.

2.10. We proposed a two tier approach to assessing the NOMs performance of RIIO-T1 as part of the RIIO-T2 price control review, and outlined the high level reviewing process. When assessing the actual NOMs, we consider a delivery of an equivalent NOMs target is on target. We also said we would consider using a dead-band around the NOMs target to take into account inherent uncertainties in the assessment methodology.

2.11. To encourage TOs to make the most appropriate asset management decisions in the best interests of consumers, we proposed to introduce financial incentives on the TOs based on our assessment of their actual NOMs‟ performance against their target. We proposed a financial reward for justified over and under delivery and a financial penalty for unjustified over and under delivery. We indicated that the size of the incentive is likely to be linked to the cost associated with over and under

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2.12. We also proposed to implement a true-up process to reconcile the financial incentives after the completion of RIIO-T1.

2.13. NGET supported our primary output of ENS and the associated financial incentive. Another respondent questioned the level of the value of lost load (VOLL), highlighting how difficult it was to reflect a level that was appropriate to the impact on different types of energy consumer.

2.14. NGET commented on our Initial Proposals for NOMs. We summarise the key points below.

2.15. NGET agreed in general with our Initial Proposals on the NOMs‟ assessment principles and welcomed our Initial Proposals for the two tier assessment approach for the NOMs. It noted that a dead-band around the NOMs‟ target was appropriate.

2.16. NGET expressed its concern on our proposed treatment of under and over delivery as it was worried that marginal reward and penalty could skew the cost benefit analysis used for asset management decision-making.

2.17. NGET was also concerned about Ofgem not setting out the details of the strength of incentives until the RIIO-T2 price control, as it felt that it would not be able to make fully informed investment decisions without understanding the parameters of any reward or penalty.

2.18. NGET proposed a mechanistic dead-band of minus and plus 5 per cent around the Replacement Priority Four (RP4) target, and requested further clarification of the trade-off between asset categories.

Final Proposals

2.19. Our Final Proposals confirm ENS as the primary output in this area and all other elements of Initial Proposals without change. We agree that the VOLL is necessarily an average level that does not reflect the impact on particular

consumers. However, our proposed range was derived through a review of a number of studies (described in detail in our Strategy Document (31 March 2011)). We are content that it balances the different impacts, and we have deliberately incorporated the RIIO sharing factor to guide NGET to make the right balance when considering the costs incurred in reducing the incidence of ENS.

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2.21. We will set out the agreed NOMs targets as binding secondary deliverables in the licence. TOs will be obliged to deliver these targets (or an equivalent taking into account trade-offs described below) for consumers. We propose to link the NOMs condition with the NOMs methodology condition, such that the targets will need to be rebased should significant changes be made to the NOMs methodology.

2.22. We expect TOs to make asset management decisions which are based on the latest information, and in the best interest of consumers. TOs can trade-off between asset categories in order to deliver an equivalent or better outcome to the NOMs target. We will not limit these trade-offs. It is for TOs to justify why they need to over-deliver in one asset category and under-deliver in another, and how the overall delivery equates to an equivalent or better level of the network risk. In the longer term we expect TOs to develop a monetisation approach to justify the trade-off.

2.23. We propose to review the performance of NOMs following the two-tier approach in our Initial Proposals. The first tier of this process is to compare the outturn NOMs against the NOMs targets, and determine if a TO delivers the NOMs targets or not. We do not think a mechanistic dead-band of plus or minus 5 per cent around the RP4 target is appropriate, because the assets in different RP groups have different impacts on the network risk and TOs have the scope to trade-off against asset categories. Therefore, we do not propose to set out a mechanistic dead-band around the NOMs targets. We will ask TOs to provide evidence to justify their achievement of the NOMs target when we compare the outturn NOMs against the NOMs targets. Where a TO is on target, we will take no further action following the first tier review.

2.24. For a TO that delivers the NOMs below or above the target, we will initiate the second tier of assessment process. We will ask the company to provide evidence to quantify the scale of the under or over-delivery, and justify whether the under or over delivery is in the best interest of consumers. When we set out the RIIO-T2 allowances for non-load related expenditure (NLRE), we will take the NOMs targets of RIIO-T1 as an opening position from which the company will deliver the NOMs

targets of RIIO-T2. Therefore, for under delivery the gap between the outturn and target NOMs of RIIO-T1 will not be funded in RIIO-T2, and for over delivery this gap will be funded through the NLRE allowance for RIIO-T2.

2.25. We recognise that asset management is a continuous process and the decision-making should not be distorted by the end of the price control period, and the financial incentives on under- or over-delivery. As a result, we propose the

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Table 2.1 – Financial incentives on NOMs

Incentives Justified Unjustified

Over delivery

Costs of over delivery are included in the RIIO-T2 allowance.

A TO would benefit from the reduced network risk

compared to the NOMs target.

A TO would be allowed to recover the financing cost of the earlier investment. An additional reward is applied.

Costs of over delivery are included in the RIIO-T2 allowance.

A TO would benefit from the reduced network risk

A TO would take the financing cost of the earlier

investment.

No additional penalty is required.

Under delivery

Avoided costs associated with under delivery are excluded from the RIIO-T2 allowance.

A TO would be exposed to the increased network risk compared to the NOMs target.

A TO would benefit from the financing cost of the

delayed investment. No additional reward is required.

Avoided costs associated with under delivery are excluded from the RIIO-T2 allowance. A TO would be exposed to the increased network risk

The benefit of the financing cost of the delayed

investment would be clawed back from a TO.

Additional penalty is applied.

2.26. In addressing NGET‟s concern on risks of financial incentives, we propose to set a fixed level of rewards and penalties in order to provide strong incentives for TOs to deliver the NOMs target while protecting them from financial stress relating to the non-delivery. The value of any penalty or reward will be 2.5 per cent of the value of the additional or avoided costs. For the avoidance of doubt, there is substantial unjustified under delivery we may consider whether it is appropriate also to use our powers relating to enforcement of licence conditions.

2.27. To illustrate how we will apply the above methodology in assessing the performance of NOMs and applying incentives, we set out a few hypothetical scenarios and cases in Appendix 1.

2.28. In response to our Initial Proposals we have discussed the NOMs measures in detail with NGET and the other TOs. We have agreed that the average circuit

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Availability: Network Access and SO:TO interaction Our Initial Proposals

2.29. Our Initial Proposals were for NGET to produce and maintain a Network Access Policy (NAP) to contribute to better SO:TO interaction and cooperation in both short-term and long-short-term network planning. We also proposed that NGET continues to engage with SPTL and SHET PLC in the development and maintenance of their respective NAPs both before the start of the RIIO-T1 control period and ongoing engagement through the price control period, for instance to engage on possible updates to the NAP (eg reflecting lessons learned).

2.30. Our separate work on SO incentives from 2013 is considering the external incentives for NGET as SO. We expect to publish Final Proposals for these incentives in 2013 following our further consultation that closes on 21 December 2012.

2.31. Through both RIIO-T1 and the project for setting SO incentives from 2013, we have worked to make sure that we align the incentives facing electricity TOs and the SO where choices can be made across the two functions that minimise overall costs to consumers, or where the costs caused by one can affect the other. The NAP development is the central area of interaction on the electricity side though we have also developed other proposals assessing the combined TO and SO impact, eg our proposals in relation to transmission losses.

Responses

2.32. Responses that considered this work were generally supportive of the NAP. One respondent highlighted the need for a co-ordinated approach to planning against the context of significant new investment being required to support new generation capacity. However, concerns were raised regarding both the type of incentive involved and its focus (ie whether it was targeting some of the areas of concern to generators and other stakeholders). In particular, the absence of an incentive on NGET to avoid disconnection impacting on generators was a concern. This

respondent proposed that these issues should be considered in an open and transparent way in the industry.

2.33. Another respondent noted concern with the degree to which SO-TO interaction is discussed within our Initial Proposals. This respondent particularly highlighted the importance of taking a wider view of system costs.

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within a month of 1 April 2013. Our proposed new licence condition requires the NAP to be a regularly reviewed and potentially updated. While the SO has a direct role in challenging the TOs on the quality of their NAP documents, other interested

stakeholders should also influence this development.

2.35. On 30 October 2012 we consulted on an initial draft of the joint NAP between SPTL and SHETPLC. NGET has played a full role in getting this draft to the stage it has reached. The principles should also provide a basis for a NAP for NGET. In this, as at Initial Proposals, we recognise the difference in NGET‟s NAP compared to SPTL and SHETLPLC in light of it being both TO and SO. Its document might serve to reflect best practice in some areas where it has long established coordination within the single company. In other areas, the NAP can provide useful transparency that might influence the company‟s approach going forward.

2.36. We agree with respondents who recognised the importance of the NAP development. We also agree with those who challenged whether its coverage was sufficiently comprehensive and whether the incentives associated with it where sufficiently strong on the TOs.

2.37. We also agree that it is important to take an overall view of system wide costs. We recognise the importance of the interaction between our work and the SO incentives post 2013. In terms of network constraint costs, the SO incentives play an important role. However, it is also important through the NAP development that TOs are incentivised to co-operate and plan together with the SO. The NAP is a live document. While we are very happy with the efforts of the companies to date, it is important that the TOs and SO continue to work on this. The NAP seeks to maintain a difficult balance. On the one hand it should be sufficiently clear so that the parties to it are held accountable for overall performance in this area. At the same time, however, this is an area where simple measures or blanket commitments are not feasible. The NAP seeks to describe not just what the TO would normally do, but circumstances where this might not be possible and what we should expect the TOs to do in such cases.

2.38. We consider that the NAP documents published within a month of 1 April 2013 should reflect continued work to understand the full range of TO activities that

interact with the SO.

2.39. We recognise the different circumstance for NGET. This is because NGET, as the one company performing both SO and TO roles, faces incentives from the costs and benefits associated with both network constraints and TO costs and benefits. We continue to see value in NGET producing its own NAP. This should provide

transparency about the existing interactions, and potentially demonstrate best practice that might be adopted in the more complex situation where separate TOs do not face the combined effect of direct TO and SO incentives.

2.40. We expect that the NAP proposals will encourage a step towards greater interaction between the SO and TOs and promote enhanced coordination of

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providing greater incentives for cross party communication and actions in this area. We will continue to work closely across the SO incentives and NAP development to consider further how to promote communication and coordination between the SO and TOs.

Customer Satisfaction Our Initial Proposals

2.41. In our Initial Proposals we proposed that NGET should have a financial incentive informed directly by the results of a survey. We noted that the survey should clearly highlight the distinction between NGET‟s activities and the other roles that it or other companies may carry out. This incentive had the limits of plus or minus 1 per cent of the particular year‟s allowed revenue. Since Initial Proposals, work has continued to progress on the details of how to implement this incentive.

2.42. The second part of our Initial Proposals in this output was provision for a possible reward for using ongoing stakeholder engagement to generate a high quality outcome. We presented initial guidance on how we would assess the case for this reward in Initial Proposals. We subsequently set out a draft guidance document with our second informal licence consultation of 30 October 2012.

2.43. Those respondents who commented specifically in this area were generally supportive. NGET provided details of its view on progress towards the incentive, and proposed a way forward on some of the mechanics of the survey incentive.

2.44. In particular, NGET‟s response set out the parameters it proposed for the consumer element of the survey based on a number of years experience. This included a baseline of 6.9/10 for the period and points above and below this level where the incentive would be limited to reflect the extreme responses appropriately.

2.45. Our Final Proposal is consistent with our Initial Proposal in overall form. However, it reflects our assessment of the further work that NGET has carried out.

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2.47. NGET has also carried out a „dry run‟ survey of its key stakeholders (other than its consumers). This is an area where it has far less experience of the likely level and variance of responses. We agree that it is appropriate that separate metrics be applied for the stakeholder survey compared to the consumer survey. The specific baseline metrics for the stakeholder element are being developed in light of evidence from the now completed dry run, and we expect NGET to propose metrics by April 2013. We may consider the stakeholder baseline and related metrics in 2016 looking at the wider evidence that we will have at that time about how stakeholders respond to this type of survey under different conditions and company performance.

2.48. We also agree with NGET‟s proposal to increase the proportion of the incentive driven by the stakeholder survey over the control with the aspiration of it having equal representation towards the end of the price control period when we will understand the results from this new element more fully. In the early years, the proportion of the two elements may be significantly different. We will consider and determine the proportion profile in April/May 2013 following NGET‟s proposal to us.

2.49. NGET noted in its response to the second informal consultation on licence modifications that it was interested in understanding if it could make use of elements of the approach SPTL and SHETPLC have followed, to make use of supporting

information alongside its survey of customer and stakeholder opinions. We see merit in both types of approach, and on the condition that the supporting information or processes support the survey results by providing information that directly implies higher quality performance in meeting customer/stakeholder needs, these are consistent with the aims of this output. However, it is too late in the process for NGET to be able to implement this from 1 April 2013. Instead this is something that could be considered with relevance to the second half of RIIO-T1 if proposed as part of any review of this incentive in 2016.

2.50. We are publishing updated Stakeholder Engagement Reward Guidance with the statutory consultation on licence modifications. Otherwise this remains as per our Initial Proposals.

Connections

2.51. We proposed that the connections output for NGET should be the timely meeting of its existing licence obligations in relation to delivering connections. Consistent with our Strategy Document, given the importance in electricity transmission of timely connections with respect to the delivery of a sustainable energy sector, we include scope for a possible financial penalty equivalent to up to 0.5 per cent of allowed base revenue.

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2.53. The timely connection obligations are already present in NGET‟s licence. However, we have been working with NGET and other TOs to draft the financial incentive.

2.54. NGET accepted the proposed output but highlighted that these were existing licence obligations and argued that it was not appropriate to apply a financial incentive to part of an existing set of obligations for delivering timely connections.

2.55. No third party response commented specifically on this issue.

2.56. We confirm our Final Proposals are for the output in this area to be the timely delivery of NGET‟s connection obligations. We recognise that NGET has a number of obligations in relation to the connections process (significantly more than the Scottish TOs because of its wider role). We also recognise that to focus a financial incentive on those obligations with specified timings where a number of others have implied but non-specific timely delivery requirements might potentially distort NGET‟s delivery approach. We propose to continue to set the output so that NGET considers all of its timely connection obligations. The Authority may use its general

enforcement powers as the route to take action in the case of under delivery with the potential for an associated financial adjustment.

2.57. We also confirm that the RIGs in this area, in addition to the information reporting requirements set up at the conclusion of Project TransmiT, should provide a good base for understanding NGET‟s performance in relation to connections delivery.

2.58. To put the importance of this output in context, we set out the Best View11_for

new transmission connected generation capacity in England and Wales over RIIO-T1 in Table 2.2. Please see the Cost assessment and uncertainty Supporting Document for further details on our efficiency assessment and risk sharing arrangements

Table 2.2 New transmission connected generation capacity over RIIO-T1 New Generation Connections

Capacity Baseline funding Uncertainty Mechanism funding

Best View total expenditure

(£m) (£m) (£m)

33,000 MW 1,042.6 - 1,042.6

11_{„Best View‟ is the expenditure that we consider the TO‟s will need to deliver the outputs under the}

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Environmental outputs Sulphur Hexafluoride (SF6)

2.59. In Initial Proposals we proposed to adopt NGET‟s business plan submission that all new assets using SF6, gas such as switchgear, are commissioned with a

target leakage rate of 0.5 per cent per annum. This leakage rate is consistent with best practice set by the International Electrotechnology Commission standard 62271-203 for high voltage switchgear.12

2.60. We also proposed that the TO‟s baseline target for SF6 emissions is calculated

annually from adding together emissions from the previous year and expected emissions from new asset additions in the current year, less the expected emissions from asset disposals in the current year. We proposed that NGET would face a financial incentive on the difference between actual SF6 emissions from assets on its

transmission system and the baseline target. The incentive would be equal to the non-traded carbon price for the amount of carbon equivalent emissions.

2.61. In Initial Proposals we rejected NGET‟s proposal to adjust the baseline target each year for a marginal increase in leakage from its existing inventory, as we consider that this would not provide the right incentive.

2.62. One third-party respondent was concerned that Ofgem‟s proposal to calculate SF6 incentive performance, based on differences between actual and calculated

baseline emissions, was inconsistent with the principles of a good incentive

mechanism, ie that it would be inappropriate to incentivise companies on estimated data.

2.63. NGET also responded on the SF6 proposals in Initial Proposals. It made the

following points:

There is an errorin paragraph 2.27 which stated that the calculated change in SF6 emissions should be added to the “actual emissions for the previous

year”. NGET considered this should read the “calculated emissions target for the previous year” to have the desired effect.

In its view, our proposal to calculate the baseline emissions target in the first year of the price control, by applying NGET‟s existing (TPCR4) Rollover SF6

emissions target (1.75 per cent) to its existing inventory, is inconsistent with our Strategy Document that “companies should use existing emissions as a starting point” (currently 1.83 per cent from the last full year).

12_{The International Electrotechnical Commission prepares and publishes International Standards for all}

electrical, electronic and related technologies collectively known as “electrotechnology”. See

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By not allowing NGET‟s proposed adjustment for higher leakage from existing assets, it considers we had set NGET a more demanding target than that faced by the Scottish TOs and that this was not justified.

Details around adding emissions from new assets in proportion to the amount of time they formed part of the TO‟s transmission system needed clarification as part of the licence drafting process.

2.64. In our Strategy Document we considered the robustness of setting an incentive regime based on an estimated measure of the SF6 output. We considered

that it would not be efficient to set a zero baseline for TOs in relation to SF6

emissions given the existing stock of SF6 assets, and the various benefits of using

such assets.13_{However, we did consider it appropriate to set an incentive regime}

that would drive companies to fully consider lifetime costs, including emissions, when appraising investment options and making operational and maintenance decisions about these assets. To do this we need to set an incentive around a baseline target that represents an operational and investment strategy that is in the interests of existing and future consumers. In the case of SF6 emissions, we consider there is a

relatively low risk from calculating a baseline target, given the available information on best practice that can be used to set the value of the parameters for this

calculation.

2.65. Therefore, we retain our position in Final Proposals for a SF6 output regime

using a calculated baseline target. We consider this is in the interests of existing and future consumers as it will provide economic incentives for TOs to make decisions around investing, operating and maintaining SF6 assets, including addressing the

worst performing assets where it is economic to do so.

2.66. NGET is correct in its response to the Initial Proposals that the baseline target for SF6 emissions should be calculated from the previous year‟s calculated baseline

target emissions rather than the actual emissions (for all years in the price control period except the first year – see below).

2.67. In relation to NGET‟s second point regarding the baseline target for SF6

emissions in the first year of the price control, we also confirm that this should be calculated as set out in the Strategy Document. NGET‟s initial baseline emissions target will take as a starting point its actual emissions in 2012/13.

2.68. We do not agree with NGET that its calculated baseline target for SF6

emissions is unjustifiably more demanding than that faced by the Scottish TOs. We have not included an adjustment factor for any of the TOs‟ Final Proposals that would add extra emissions each year to the calculated baseline for a deterioration in the leakage of existing assets. Evidence provided during the assessment of the Scottish TOs‟ business plans demonstrated that the proposed leakage rates comply with the

13_{Equipment containing SF}

6 provides a safe and cost efficient electrical insulation medium,

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standards set by the IEC for assets containing SF6 and SF6 mixtures. We also note

that one Scottish TO will add emissions to its baseline target from new SF6 assets

that form part of large transmission system reinforcements, and that these will be calculated at the manufacturers‟ specified leakage rate.

2.69. We have also informed our decisions on baseline targets for SF6 for each TO

through the particular TO‟s track record in the SF6 leakage scheme under TPCR4. We

expect a TO who has previously performed well, such as NGET, and which has

developed processes and gained a lot of experience in operating and managing these assets, will continue to benefit from these under the RIIO-T1 regime. Accordingly, we also think it is appropriate that the incentive regime should provide sufficient stretch for NGET to seek further improvements in its approach where it is economic to do so. For these reasons we confirm for Final Proposals that we are not including an

adjustment to NGET‟s calculated baseline for deterioration in the leakage from existing assets.

Business Carbon Footprint

2.70. In Initial Proposals we proposed that NGET report annually to stakeholders on its scope 1 and scope 2 greenhouse gas (GHG), or carbon dioxide equivalent,

emissions throughout the RIIO-T1 period.14_{We also proposed that NGET face}

reputational incentives only on its business carbon footprint (BCF) reporting. We also said that NGET would need to report on its BCF at the business level to enable

accurate reporting on its carbon equivalent GHG emissions from the transmission business.

2.71. We did not receive any specific responses in relation to our BCF proposals set out in Initial Proposals.

2.72. We confirm that our proposals as consulted on in Initial Proposals are unchanged for our Final Proposals in this area.

Transmission Losses

14_{Scope 1 are direct GHG emissions that occur from sources that are owned and controlled by the}

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2.73. In Initial Proposals we proposed to set reputational incentives on NGET in relation to its overall approach to contributing to fewer transmission losses where it can do so and provide long term value to consumers.

2.74. We also proposed that NGET should publish its strategy for transmission losses and report to stakeholders annually on its progress in implementing its

strategy. We also said that this should include an estimate of the impact this has had on transmission losses in its transmission area.

2.75. Two respondents supported the proposal to set a reputational incentive on losses because the outcome can be significantly affected by the actions of third parties. They also supported the proposed design of the mechanism.

2.76. We confirm our proposals as consulted on in Initial Proposals are unchanged for our Final Proposals in this area.

Visual amenity

Our Initial Proposals – new transmission infrastructure

2.77. In Initial Proposals, we proposed that NGET efficiently address the visual amenity impacts of new transmission infrastructure where necessary to obtain development consent from the Secretary of State. This is consistent with NGET‟s requirements as a proposer of potential new developments under the Planning Act 2008, and also NGET‟s obligation under its transmission licence to maintain and develop its transmission system in an economical and efficient manner.

2.78. We proposed to adopt NGET‟s submission for a baseline allowance equivalent to the efficient costs of deploying underground cabling technologies for 10 per cent of the new transmission assets potentially required in RIIO-T1. This was a working assumption to use as a starting point. To deal with uncertainty around whether this is the actual level needed over the price control period we also proposed to include a volume driver to adjust NGET‟s revenue for the level of mitigation technologies needed to obtain development consent. For more information on the operation of the Planning Requirements volume driver we refer the reader to the Cost assessment and uncertainty Supporting Document.

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2.80. We received several responses to Initial Proposals for mitigating the visual amenity impacts of new infrastructure. The overwhelming majority of third-party stakeholders supported the inclusion of baseline funding with an uncertainty mechanism to adjust allowances if more or less mitigation is required to obtain development consent during the price control.

2.81. NGET welcomed the proposals in our Initial Proposals as these were aligned with the approach set out in its business plan. NGET also sought clarification on Ofgem‟s process for reviewing the uncertainty mechanism and said it should also be able to trigger a review.

2.82. Third-party stakeholders also raised the following issues in relation to arrangements by which the mitigation required for new infrastructure would be determined:

Several stakeholders said that a study into consumer willingness to pay for undergrounding new transmission infrastructure was needed, to inform both the companies, Ofgem and the Planning Inspectorate about the „economic and efficient‟ level of mitigation. Stakeholders argued that without such a study there is little information available to inform NGET on how it should efficiently address the visual amenity impacts of new infrastructure proposals.

Generally the same stakeholders argued that Ofgem should require the TOs to undertake this analysis as part of their business planning process and that it was important that this was done at a national level because it is greater than local significance.

Several stakeholders also sought clarification on Ofgem‟s role as statutory consultee on new transmission infrastructure under the Planning Act 2008. There was also a similar call for further clarification on the interface between regulatory and planning regimes.

In a similar vein these stakeholders also thought that Ofgem should provide more guidance on NGET‟s regulatory and legislative obligations under the Electricity Act in the context of seeking planning decisions, to ensure that the company did not place greater weight on particular solutions based primarily upon their cost as opposed to their overall sustainability.

2.83. In light of the widespread stakeholder support for the proposal consulted on in Initial Proposals we retain this approach for Final Proposals largely unchanged.

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help protect consumers in the event that actual unit costs change significantly over the price control period by sharing savings between the company and its customers. We also consider that we will have sufficient opportunity as a statutory consultee under the Planning Act 2008 to prompt NGET to provide further justification that its investment proposals represent good value for existing and future consumers.

2.85. We agree with third-party stakeholders that there is a potential role for consumer willingness to pay (WTP) studies, as well as other information on landscape quality and features of special interest, to inform NGET on the efficient level of different technologies when developing its proposals. However, it is

ultimately for NGET to develop its proposals and the need for mitigation on a case by case basis by working with stakeholders during the planning process rather than any fixed funding rule set through the price control.

2.86. We acknowledge stakeholders‟ request for further clarification on Ofgem‟s role as statutory consultee under the Planning Act 2008 and the interface between

regulatory and planning regimes. We intend to update our Visual Amenity factsheet to address these questions including more information on the respective roles of the TOs, Ofgem and the relevant planning authorities in the development of transmission infrastructure.

2.87. We also acknowledge stakeholders‟ request that Ofgem should provide more guidance to NGET on its regulatory and legislative obligations under the Electricity Act. We believe that through RIIO we have given all of the network companies a very strong steer that the solutions they propose contribute to overall sustainability, and encompass a wider evaluation of value for money for existing and future consumers rather than focusing on short-term cost efficiency.

Our Initial Proposals – existing infrastructure in designated areas

2.88. In Initial Proposals we consulted on an initial expenditure cap of £100m to allow all electricity TOs to start work on mitigating impacts of existing infrastructure in designated areas at the beginning of RIIO-T1. We also said we wanted further analysis of consumer WTP from the TOs, such as median WTP estimates, to inform the amount of the total expenditure cap for RIIO-T1. We also confirmed that it was our intention that the expenditure cap would be available nationally for all electricity TOs.

2.89. In relation to the governance of the expenditure cap, we proposed that the TOs would need to develop a policy for delivering visual amenity outputs in designated areas. We also proposed that Ofgem would approve this policy before TOs can access funding under the expenditure cap.15

15_{The TOs could develop this policy either before the start of RIIO-T1 or during RIIO-T1 but in order to}

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2.90. We received 16 responses from third parties in relation to mitigation of impacts from existing infrastructure on visual amenity in designated areas. National Grid also included a section in their response on the proposals on Initial Proposals for the existing infrastructure expenditure cap.

2.91. There was overall support for the introduction of a mitigation programme as part of RIIO-T1 to reduce the visual amenity impacts of existing transmission

infrastructure. However, many stakeholders raised the following issues in relation to our Initial Proposals:

Most stakeholders (12 out of 16) were concerned that Ofgem had not adopted the £1.1bn amount NGET proposed in its business plan for the existing

infrastructure funding pot. These stakeholders said the underlying analysis is a robust estimate of consumer WTP to inform the expenditure cap. In

addition, stakeholders believed that NGET‟s proposal to set the national expenditure cap from the average WTP estimate is consistent with previous decisions by Ofgem to setting the undergrounding allowance in the fifth distribution price control.

Two stakeholders supported Ofgem‟s alternative proposal of £100m for the start of the price control. One stakeholder did not think NGET had made a convincing case for a higher expenditure cap. The other stakeholder thought a smaller amount was appropriate because of affordability issues and the

potential impact of higher costs on household and business finances alike. At least half of stakeholders wanted further clarity on Ofgem‟s rationale for setting an initial expenditure cap for the start of the price control at £100m. Stakeholders said that in proposing a £100m initial allowance Ofgem‟s

interpretation of consumers‟ interest is too conservative and could undermine a strategic assessment of potential visual amenity improvements. Several stakeholders argued that the proposed amount of the expenditure cap is inherently conservative because it is based on measures of WTP rather than Willingness to Accept (WTA) which are generally higher and double counts affordability concerns.

Several stakeholders expressed concerns that the expenditure cap of £100m proposed by Ofgem would not be enough to deliver meaningful visual amenity improvements, and asked for more information about how the cap could be increased if further evidence was supplied.

More than half of stakeholders thought the intent of the policy should be to address impacts from existing infrastructure on designated areas, such that it could be used to mitigate existing infrastructure in, or in close proximity to, a designated area.

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One stakeholder was concerned that Scotland would not receive its fair share of the expenditure cap, and recommended that funding was allocated and ring-fenced geographically. The stakeholder also had concerns that Scotland could miss out because in its view the two Scottish TOs had shown little inclination to engage fully in this area. The stakeholder also noted that as Scotland did not have Areas of Outstanding Natural Beauty (AONB), that we should recognise Scottish designated National Scenic Areas (NSAs) under the scheme as having the same status.

Several stakeholders expressed concern about the „use it or lose it‟ nature of the allowance, arguing that delivering these works could involve protracted negotiations with landowners, and involved technical complexity that might mean not all the funding could be used over the price control period.

Several stakeholders said that affordability in the current economic situation was a short term concern, and that Ofgem would have to balance this against more long-term considerations and duties such as contributing to sustainable development.

Many stakeholders also set out their views for objectives and criteria to be included by the TOs in the governing policy to select and prioritise schemes.

Final Proposals

2.92. As stated in the Initial Proposals, we have confidence that the WTP survey method is robust and was designed to counter the potential biases and other issues highlighted for us by London Economics in its report setting out best practice for such studies.16_{Accordingly, we accept the results overall as evidence of domestic}

consumers‟ WTP for such benefits over the coming price control period. Nonetheless, we took a conservative approach in Initial Proposals because of the materiality of the expenditure cap NGET proposed, and because NGET had not tested its proposal with stakeholders before submission to Ofgem.

2.93. We have also further considered, since publishing the Initial Proposals, the high proportion of survey respondents who said they chose to pay for mitigation for the benefit of the country as a whole, despite the additional costs. As regulator we need to weigh this against the proportion of survey respondents who had concerns about affordability and value for money. Respondents‟ motivations and issues raise important questions for Ofgem about the acceptability and fairness of additional costs among the broader consumer base, alongside our duty to have regard to the sustainable development benefits that could be delivered.

2.94. Taking into account stakeholder responses, and the above considerations, we have refined our Final Proposals in this area. We retain our view that the level of expenditure should be informed by estimates of the median WTP rather than

16_{We commissioned London Economics to review NGET‟s July 2011 study of consumer attitudes to}

undergrounding. In this report they set out the key features of best practice for conducting WTP studies. A copy of London Economics report is available at:

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adopting the approach in DPCR5 of setting the cap based on the average WTP. Importantly, the median represents the amount that at least 50 per cent of survey respondents are willing to pay for mitigation. Setting the cap in line with the median gives us more confidence that it would be seen as legitimate with the wider

consumer base (including electricity consumers that were not covered by the survey, such as business customers and large users who together incur a large share of total transmission charges), and help to ensure support for a mitigation programme over the long term.

2.95. We have decided to increase the level of the initial expenditure cap available at the start of RIIO-T1 in Final Proposals to £500m. This amount gives a much

stronger steer of our ambition for this measure to deliver significant improvements in designated areas during RIIO-T1, and also ensures that the companies have a

meaningful amount of funding at the start of the price control for a wider range of potential projects.

2.96. We have set this value taking into account the results of the WTP survey. While we expect the median WTP to be less than the average WTP it is unlikely to be lower than half the value, because only 20 per cent of respondents choose to pay nothing extra for any form of mitigation, ie the final value based on the median will be greater than £500m. We also consider it is appropriate to set the initial

expenditure cap at this level because this will ensure there is enough of an incentive for the TOs to undertake further analysis to inform the total value of the cap for RIIO-T1, ie we expect the median WTP to be significantly higher than £500m.

2.97. The process for updating the amount of the expenditure cap during the price control period will be triggered when one or more of the TOs request Ofgem to review the amount of the expenditure cap, and present new evidence on the median WTP of consumers. Before the Authority makes a decision, we will consult with interested stakeholders on our assessment of the request to revise the level of the cap available under the price control period. We will also publish Ofgem‟s decision so that all stakeholders are aware of the total funding available under the programme, taking into account consultation responses on our assessment.

2.98. We retain our position in Initial Proposals that the expenditure cap is available to SHETPLC, SPTL and NGET to progress improvements in their respective

transmission areas. We note that all GB consumers will be contributing to the overall costs of the scheme. In consultation responses, stakeholders said that a programme of projects should be considered on a national basis and that all TOs should actively participate and deliver improvements if projects with sufficient merit are identified in their transmission area. Stakeholders also said that the best way to achieve this would be for the selection of projects to be based on a transparent and coordinated assessment of the benefits, costs and practical feasibility of candidate projects.

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forward a joined up approach with each other, and relevant stakeholders, to develop both guiding principles and an open process to identify and prioritise candidate projects on a national basis.

2.100. We have also further considered stakeholders‟ feedback that proposals in Initial Proposals should be broadened out to include other designated landscapes such as NSA in Scotland and Heritage Coasts (HC) in England and Wales. We do not have specific positive obligations with respect to these other designations, as is the case with National Parks (NP) and AONB. However, we have looked further at this issue in the context of our duties to have regard to the promotion of sustainable development more generally.

2.101. We have decided to extend the scope of the expenditure cap to include Scottish designated NSA. We consider this is appropriate from a sustainable development perspective because NSA are the Scottish equivalent of AONB in England and Wales. With more than 35 designated NSA in Scotland that are distinct from the Cairngorms NP and the Loch Lomond & Trossachs NP this will increase the potential list of candidate projects in Scotland. The inclusion of Scottish NSA will also improve parity of opportunity in Scotland compared to England and Wales to make use of the expenditure cap.

2.102. We have decided not to extend the cap to cover any other designated landscapes at this time. For some, such as Heritage Coasts, this is largely

unnecessary as the majority are already covered by virtue of being part of an AONB or NP. For other designations we do not have enough information to assess the potential suitability of extending the mitigation programme into such areas. We recognise that there could be important issues to consider such as the impact on protected wildlife or potential disturbance to sensitive archaeological or ecological features which should be explored further through consultation with stakeholders.

2.103. We also considered stakeholders‟ feedback that the expenditure cap and mitigation programme should also include existing infrastructure in close proximity to a designated area. While we recognise that there could be issues around the

boundaries of designated areas we do not consider it would be appropriate, given the costs involved, to make a rule in Final Proposals about points visible from a

designated area being the same as within it. We believe it is more appropriate that the costs and benefits of mitigation near to the boundary of a designated area are assessed alongside other candidate projects such that any tradeoffs can be fully considered by stakeholders.

Broad Environmental Measure

RIIO-T1: Final Proposals for National Grid Electricity Transmission and National Grid Gas